Reality Disconnect, Again

So many news headlines these days take my breath away because they are just so intent on pushing liberal/progressive views. Today offered one of the worst: “Last Bernanke Years Shows No Sign of Buyer’s Remorse” online at Bloomberg. The article is congratulating Bernanke for navigating the last six years without seeing high rates of consumer price increases. I know that many people disagree with the government’s claim that prices have not been climbing more rapidly, but for the issue in the article, it doesn’t matter. What matters is the underlying, widely accepted view of the article. That view holds that it is okay to focus very narrowly on an isolated, micro point, and assert that it means something. Using Dr. Leonard Peikoff’s DIM nomenclature, this is at best D1, possibly D2.

A knee-jerk, but nevertheless appropriate, response to this article would be to observe that there is less upward price pressure during a recession/depression. As Bernanke has responsibility for the recession, which he shares with some other esteemed governmental and legislative fools, it is morally outrageous to give him credit for the accidental consequence that consumer prices aren’t raising fast enough for people to be angry. Supposedly, Bernanke meant for prices to remain stable. But that is not true. Bernanke has been trying for a 2.5% rate of increase, and he hasn’t been able to get there, regardless of the amount of made-up money he has pushed toward the economy. Bernanke is being given credit for something he didn’t want and really thinks is bad.

Furthermore, focusing on the period of the last few years fails to observe that the consequences of his policies are going to be disasters for many more years into the future. This is another sign of the D mentality: the future isn’t real to them. What happens tomorrow is always a complete surprise. When you discard causality, the future has no relation to the present. This is especially true of government actions. They say that their new law or control will eliminate some perceived error in economic activity. They never check to see if the law or regulation had any effect on that problem, never. They do apparently assume that merely making the law is a sufficient “cause” for the problem to go away. But they do not actually realize that their action might cause some other, unwanted effect, in spite of the current wave of the hand at “unintended consequences.” The possibility is not part of their view of the world because they don’t understand cause and effect.

Bernanke is such an eloquent example. He was surprised by every turn of the economy from the day he took office until today. He has denied that his actions have had any negative consequence. He just won’t believe it (see my blog on his speech about the cause of the housing price boom). He has one response for any kind of economic situation: put more, lots more, money into the economy. More money is always good. And if wonderful things don’t happen, it is because really bad things were happening, which were staved off by the money he did put in. “Just think,” he might say, “how bad things would have been if I hadn’t acted.” Thus he proclaimed himself hero of the universe when he pushed a trillion of so into the economy during the beginning of the recession. Never mind that he has had to do the same thing repeatedly since. In his view that is because capitalism had let us down drastically in 2007.

This is another aspect of the D1 (he is a D1 because he does have a theory, an integration, which he thinks is founded in science). The theory is true, and thus must be applied, regardless of the actual results. He is not capable of reevaluating the theory.

All of this underscores the vital nature of philosophy in our battle to change the culture. We can’t argue or collaborate with a D. There is no common ground, actually no ground at all for him. We have to just replace him. In general, the same is true with the M. In the sense of using their theory, the M holds his ideas in much the same way as the D: the theory cannot be touched by reason or consequences.

We have to address ourselves to those people who aren’t contorted into either anti-reason methodology. That means the young and those individuals who somehow survived today’s schooling with some of their brains intact. It isn’t easy.

From Bernanke's Lips

While I do have one bone to pick with John Allison, I have found his book, The Financial Crisis and the Free Market Cure, to be a source for many insights into our economy and how it works. One point he made just popped into my head as I was reading another silly article.

The article, “Loose Lips Sink Euro Bond Markets in Crisis: Cutting Research,” cites “research” about the effect of 25,000 news releases by eruo-zone governments on the sovereign bond markets. They did a statistical analysis on the words and content of all of those news releases. Real science, right? They found that positive announcements tended to have a positive affect and that negative, confusing, or conflicting announcements tended to have adverse affects on the market, i.e., interest rates went higher. Like I said, real science! There was no indication in the news article if the study considered the effect of lies or self-serving political announcements.

Mr. Allison’s point was that every time the Federal Reserve Board made an economic prediction, it was wrong, significantly wrong. That’s right, Mr. Allison points our that the Fed has a perfect record of understanding what was going to happen. Always, 100% wrong. They have no idea what is going to be the results of their policies.

Think of Bernanke’s pronouncements from 2005 to 2008. He was asked how things were. He said, “Fine.” When housing prices skyrocketed, Bernanke said everything was “Fine.” When it was noticed that subprime mortgages began to fail, he said that the economy was “Fine.” When Lehman Brothers failed, Bernanke said that everything was “Fine.” When the economy went into crisis, businesses failed, people lost their incomes, and asset values collapsed, Bernanke claimed that he saved the world.

So today, everyone is hanging on every word that Bernanke says and the market is going up and down like a yo-yo. People are ignoring that there is little to zero investment occurring that would expand production, that there is little growth in employment (of any kind, let alone highly productive ones) to put the millions who lost their jobs back to work, that government debt is swamping our ability to cover current expenses, or that expanded regulation is close to choking our economy.

Why are people paying so much attention to Bernanke? Well, he does have a lot of power. Speaks well of us U.S. voters, doesn’t it. It is also true that today the government, including the Fed, is a major force, if not the major force, in the economy. That’s not good either.

What are we going to do to change it?

But, also important to anyone living in the U.S. or in some way dependent upon the condition of the U.S. economy (nearly everyone alive, right?): you best remember Bernanke’s track record. If he says that were heading into a drought, you better be ready for a flood and our ships won’t float either

Basic Economics: Savings Accounts

Looking at the modern relationships between interest rates, taxes, and price inflation, I have wondered why anyone would put money into savings accounts or buy bonds, especially U.S. government bonds. A savings account, earning 1.6% (The top rate offered by my credit union recently.), after taxes of say 20% and price inflation of 2% gives you a guaranteed annual loss of 0.72%! The situation for bonds isn’t that much better, if at all. For someone with a higher income, with higher tax rates, the loss is substantially greater .

On the other hand, I know that savings accounts have historically been the primary savings vehicle in the U.S. I know from 100 Voices that Ayn Rand held her money from the sales of her novels in savings accounts. What is the difference between then, even as late as the 1970s and the 1990s, which is when I first realized the problem.

In thinking about this issue, one of the first things I saw is that interest rates have been declining as a trend since the spike in 1990. At that time I had a mortgage at 10.75%. The decline in interest rates since then has been the consequence of the Fed’s view that below market interest rates on loans encourages consumption and business activity and that if they don’t have the economic activity that they want, they decide they should lower rates more. Each round of recession and boom and financial crisis over the last twenty plus years has seen the Fed pushing short-term interest rates lower and lower. Today, the short-term rates are about as low as then can go. The rate the Fed controls directly, the rate it charges banks to borrow overnight funds for their Fed “reserves” (deposits) is zero to 0.25%. (Some recent auctions of German government short-term bonds have seen negative interest rates.) And, for the third time since 2009, they are trying to lower medium and long-term rates with “quantitative easing.”

So, first, the problem I am seeing is a very recent event. What are some of the consequences?

First there is the complete disassociation of savings and capital. The creation and use of capital is a vitally important activity in an economy. The creation and use of capital causes prosperity, not to mention the survival of our population. A population as large as ours cannot survive (or occur) without industrialization. Just to maintain industrialization requires capital. Economies either grow or contract. There is no equilibrium.

Over the last twenty years the number of households that have ownership in corporations, i.e., own stocks, has gone up significantly. One major reason is that people recognize that they have to have a more rapid growth in their retirement savings than can be provided by bank savings accounts. The need is two fold. With taxes and other restraints on creating wealth, they are not able to save enough. And then, price inflation has a double impact in that not only will it make the process of saving enough difficult, but it will also make the amount the retiree needs to live increase significantly and unpredictably. Even a 2% price inflation rate is a danger. That means that in just twenty years, a retiree would need 25% more cash for the same standard of living. Since many retirees live longer than that in retirement, and the percentage of people with such long lives is growing, the impact of even small amounts of price inflation is significant and ignored by the government planners. Bernanke has recently remarked that the effect of the Fed’s goal of 2% price inflation on retirees is unimportant in policy decisions.

You might think that a higher percentage of stockownerships is good for the economy. I’m not so sure. I was, but my view is changing. There is a difference between creating capital and owning existing capital. Saving and putting your money directly into a new or growing business is creating capital. Buying a stock from another owner is not.

Consider what should happen when you put your money into a bank savings account. (I am going to ignore the consumer loans and the loans to business for normal business activities.) Businesses come to banks for the purpose of borrowing money to start a new business or grow their existing company. This is the direct application of capital, i.e., new productive activity. Here we also see the division of labor at work. The person who saved the capital is engaged in his own profession or job and by saving, he is putting money into the hands of the banker whose profession is apprising risk and opportunity in expanding production. Then there are the businessmen who compete for funds by presenting their plans and expectations of profit.

The normal person does not have the expertise to appraise business opportunities. (Although in a rational culture he would have a better understand of the reality of business activity than people do today.) This is true in the case where people already know something about the industry. Some financial writers have advised investors to place their money in industries in which they are familiar. It isn’t a bad idea, but it does not address the additional need to be able to appraise the financial, managerial, and competitive strength of a company. Correctly understanding the context for investing is difficult enough for the professional, especially in today’s complex economy. For those who do not have the relevant education, experience or time, the prospects are very poor. No wonder everyone is so hopped up on the gambling metaphor for investing.

The need for non-professional investors to put their savings into asset markets is part of the make-up of the two recent booms: tech stocks and residential real estate. Without the amateur investor, both booms would have been less dramatic. Note that many of these investors lost lots of money, right along side the so-called professionals. This is over and above the normal losses that the non-professional investor tends to lose in the normal course of events. Some professionals use the activity of the individual investor as a contra indicator. If individual investors are buying, the reasoning goes, it is time to sell. Every study that I have seen clearly concludes that the non-professional consistently looses money investing in asset markets.

Then, over the last twelve years, as I have indicated in a previous post, the equity markets have failed to bring positive returns. Comparing equal dollars of purchasing power, today’s Dow (without including dividends or taxes) is 20% to 25% below the level at the end of the tech stock boom.

In fact, the only asset class that has shown consistent positive returns in the last decade is long-term bonds. But that brings us back to the beginning point, the Fed’s push to lower interest rates, because the reason long-term bonds have shown a gain is that interest rates keep falling. When interest rates begin to go up, watch out. Look at the returns of the bondholders of Greece, Spain, and Italy. When the interest rates on these dead bonds moved from less than 3% to near 6% or more, bond holders lost about 50% of their capital on the secondary market. To me, even 6% or 7% doesn’t seem very high when I wonder if the bonds will be repaid, or repaid with money worth anything.

There are surely lots of other consequences of the Fed’s disastrous decisions. Many are clearly visible, including the continued recession we are suffering through. (Officially the recession ended, but the psychology is still that of a recession, the unemployment level is that of a recession, and the government is doing all it can to keep us there, just like it did in the 1930s.) But the consequences that I have discussed are the ones I have recently added to my list.

But then there is the important question: Is the use of savings accounts by people who aren’t financial professionals a good thing in a laissez-faire economy and how?

The first thing to realize is that in a laissez-faire economy prices and wages tend to fall over time, which is the consequence of having a money immune from government manipulation. Prices fall faster than wages so that there is a continuous raise in the standard of living. That means that the dollar you place in a savings account will have a greater purchasing power over time even without consideration of interest paid.

The second important issue is the level of what is called the ordinary interest rate. That is the amount of return required for a person to delay consumption. This interest rate does not include consideration of risk, etc. I have seen suggestions that the rate of ordinary interest tends to be around 1%. That is, the normal person would be willing to put off spending $100 if in one year they had $101, assuming a laissez-faire economy. Other issues, such as the supply of physical capital (one market where supply does play a role in price) and risk factors, increase the interest rate within different market contexts.

So, if a savings account offered 2% interest, it was a great deal. The same is true for bonds issued by businesses. Saving for retirement would require much less of a struggle, later medical bills would be less of a problem, and our standard of living would continue to raise and we could have the flying car (see, my avatar means something – what we have lost due to government interference!).

Then, money placed into savings accounts was then loaned by banks to businesses who were credit worthy and had the best available plans for additional profits. Savings, that is capital, was accumulated and placed in the service of wealth creation, capitalism. That is basic banking.

I think much of the concern and fuss over fractional banking is based upon the view that banks are warehouses rather than institutions involved in the accumulation of capital. In the modern world, even ignoring the stupid, forced level of interest rates required by welfare state banking theory, savings have been diverted from banks and their major source of funds are demand deposits.

While unused demand deposits, and the goods represented by that money, are a kind of unintentional savings, real savings involves conscious decision and results in the funds being placed accordingly. When real savings is placed into profitable enterprise, and market rates of interest paid, investing and profit making activity would actually be a less risky activity.

With the manipulation of the money supply, the extensive regulation of the financial community, and the control of interest rates, none of the prices for savings or the factors of production reflect any part of the reality of business activity, market opportunities, or costs (not to mention political pull). Who knows what can or will happen when no facts are available for reason to evaluate.

So my conclusion is that in a laissez-faire economy, placing your money in savings accounts and buying bonds (of businesses) is a sane and personally beneficial decision.

In our economy, the government has pretty much taken way sane and beneficial opportunities. If you accept the idea that one should know what one is doing, then probably 90% of the investing public is acting irrationally. They do not understand the world as it currently functions, including the existing markets and the impact of government regulations and manipulations. Yes, I think that is true of many of my readers. Sorry.

Uncle Ben Spoke, and a couple Economics Lessons

Uncle Ben had a press conference a couple weeks ago – a first for a Fed Chairman.  (Uncle Ben Bernanke, Chairman of the Federal Reserve Board.)

And didn’t really say anything. Transparent! Transparent = Nothing! Fits.

So, Ben said that inflation expectations are low and that core inflation is low and the Fed isn’t responsible for anything that might be bad and everything that the Fed is responsible for is good and coming along, perhaps slowly, but coming along. Notice that when he discusses his policies he refers to the models and intellectual justifications, not to the results and consequences, not to the facts of reality.

Bernanke’s history at the Fed has shown that he does not believe that any of the problems that the economy has experienced are the result of the Fed’s policies. The Fed does the right thing and somehow, some other source of economic action causes things to go wrong. The Fed, Bernanke, is always right. He knows that he is right. He doesn’t know why things go bad.

More fundamentally, no result could cause Bernanke to question his beliefs. He is not reality oriented. He also hasn’t seen anything bad that was coming. In 2004, 2005, 2006, and 2007 he kept saying that everything was just fine. Then, in 2008, he said things weren’t doing so badly. Then, in 2009, he said that his actions had saved us all.

He does have the power, by being the Federal Reserve Board Chairman, to manipulate the economy. And he is intent on doing so. We are at his mercy, at the mercy of his mistaken views, at the mercy of his lack of contact with reality. We, the American people and the world, will continue to suffer.

But here is where I get very upset with the people who are criticizing him, those who post blogs and comments, etc. I include many Objectivists. The only thing they apparently see is inflation. Apparently, if commodity, food, and oil prices weren’t rising, they would have no problem with Bernanke. Well, they would probably howl that Bernanke’s policies would lead to inflation, but it would always be inflation, inflation, inflation. One note Johnnys.

It is certainly the case that the Fed’s only purview is monetary policy, i.e., pumping money. But controlling the money supply has other consequences, and to ignore those consequences is to leave Bernanke and his fellow government manipulators a free area of activity, damaging activity, deadly activity, immoral activity.

For example, one of the actions of the Fed is aimed at keeping interest rates low (the activity they have some direct control over, as opposed to the money supply, which is controlled indirectly) completely distorts a basic, key price in the economy. Interest rates are important in an economy and impact many decisions and other prices. People are just not able to make rational decisions in such an environment. I mean, since rationality consists of observing reality and acting accordingly, without basic, accurate information about the economic situation, rational decision-making is not possible.

I know that some argue that businessmen are smart and know that the interest rates do not reflect reality and adjust their thinking. I am sure that they do. But how much do they adjust? What can they think is the reality of the situation? I mean, without the facts, the businessman is only guessing. It might be a smart, experienced, wise guess. But it is still a guess, not knowledge. As a guess, it could still be way off. It could still be damaging. Further, since it has been literally decades since a market for capital has existed, any guess cannot be based on any actual market experience. A businessman’s wisdom is not an argument that changes the significance or the damage done by the manipulation of interest rates by the Fed.

The impact of the Fed is much wider than real or potential rising prices. People need to stop thinking that inflation is the only or even the major issue in every situation.

By the way, I was looking at copper and corn, two of the “commodities” that people are referring to when they say that “commodity” prices are rising. It may not be significant (you can’t really tell until sometime later), but both have backed off their recent high prices. I don’t know why yet, that is, I don’t know if it is a lowering of demand or if new production has come into the market, but if this trend continues, or if they just don’t keep going up, the contention that the Fed causes every bad economic consequence in the world will be even more questionable. Then the problem of being unscientific, i.e., not looking for causes, will have bigger consequences because it will make all criticism of the Fed look unsupported.

There is another error in the thinking of many about the economy. It is thinking that by knowing at least some of the consequences of the actions of government in the economy that one knows something about economics. Recently I have seen people dismiss comments I have made merely because I didn’t attribute what they viewed as negative economic consequences to a government. It is as if the only economic actor who has any efficacy is the government. Certainly, they conclude, that if anything happens that they don’t like it must be the fault of the government. There are several fallacies involved in such thinking, e.g., affirming the consequence, but the most basic fallacy is just not having taken the effort to learning the subject.

As a reader of Ayn Rand, we have learned that one must use one’s own judgment. This is important for many different, fundamental reasons, including moral ones. There is, however, an important context: a judgment without knowledge is not rational. That is, in order to decide, judge, conclude, make any kind of rational decision, one has to have knowledge of reality. Making a statement, declaring a judgment about an economic subject means you have to know economics, the fundamentals, and not marginally.

The fundamentals of economics involve the actions of individuals, people, acting as producers and consumers. It involves markets, prices, costs, production, and making economic choices. The actions of government overlay the reality of production and consumption. The actions of government affect what people do, the prices resulting from market actions, what people ultimately produce and consume. But the governmental actions are not fundamental to an economy, or its study. The fundamentals are the reason for the existence of markets, prices, and the creation of wealth. People acting for their own benefit are efficacious. Government action only corrupts.

It is often next to impossible to foretell what the results of government action is going to be because of the complexity of an economy, of the large number of actors, of differing interests and motives. In that government action is intended to get people to act differently than they would normally, the results cannot be good. But to identify and understand those results, you have to include the primary market participants. To ignore them is to drop the context. The primary actors are the individuals.

Outlook: The Economy and Inflation

If I haven’t mentioned this before, let me do so now: keep an eye on “business news”. So many people are focused on the political issues that they don’t take time to look at the business pages. People also tend to consider business news as very specialized, I think. I mean that the stories involve finance and accounting concepts that are not sufficiently understood by the average, intelligent person. I would agree if the articles on the business pages in the normal daily newspaper or news web site were about actual businesses and markets, etc. Most articles, unfortunately, are actually about the government and its activities. What would pass as actual news in the business world is ignored there just as real news is ignored in the other sections. Further, the “reporters” in the business section are not people with an education in business, finance, or economics. Nor do they have business backgrounds or even a history of intelligent investing. They are people with journalism degrees who could not make it to the front pages. Years ago someone did a survey of the people writing for Money Magazine. They found that few of the writers had any investment background. The writers for Money Magazine were young, inexperienced, and had bought into the Money Magazine “philosophy” (and advertising strategy) without question.

So it would seem that I have just given you good reasons to ignore the business pages. Well, even so, it is the reports on the government that you need to look out for. A few of those reports are considered significant enough to reach the front page. Many of the others are important to know about. You need to have a broader view of the economy we live in and its prospects to better understand what could happen in the future. You need that for yourself, to better plan for yourself and your family.

For example, some people are carrying on about high inflation and you might think that inflation is raging and creating havoc. Look around you. Do you see prices in general going up? Significantly? There is some, of course, but nothing big has happened as of yet and may not for a while. People who are carrying on about inflation happening now are ignoring the actual situation. (I am not suggesting that there is no threat of inflation or hyperinflation. There is. But it is a threat, a possibility and can be avoided.) Many people are ignoring the issues of Social Security and Medicare and their impact on the budget, today. You don’t keep track of this stuff without looking at the business section (and reading this blog, of course!).

Okay, so lets talk about outlook, or what I have called the Inflation Watch in the past. This time I am broadening my focus.

In spite of all the pushing, money pumping, stimulating, and general noise making, the government, including BO and Bernanke, has been unable to get the economy functioning, producing consistently, and growing. They don’t know why. Their mental framework, the “understanding of the world” they utilize to make decisions, has not brought them to the shining success they expected. But don’t despair; they know why it didn’t work. We didn’t cooperate, we being the banks, the business, the capitalists, the consumers, all of the non-government types. It is our fault. They will just have to try harder. Don’t worry. They, BO and his gang and Bernanke and his colleagues, will not question their ideas.

In the meantime, the economy is floating along, not improving, deteriorating marginally in areas that are hidden. More houses are being foreclosed upon (funny how there are few if any news reports about foreclosures these days, which was big stuff a year or two ago). BO is considering “restructuring” Fanny Mae and Freddy Mac. You know that won’t be good.

There is more unemployment and few new jobs, relative to the available workforce. (Notice that in my area, just outside of Washington, DC, unemployment is low. Isn’t that strange. Notice also the various comparisons between federal government employee incomes and the private sector.) Industrial production rose for a while, but has now slowed, if not stopped growing. Imports are again exceeding exports significantly, and the gap is growing. The balance of payments (all money transfers as opposed to just trade) shows that foreigners are still keeping dollars (idiots).

Not to be left out, foreign governments are doing just as much to screw things up as the U.S. government. Many who are looking at the Chinese to be shining stars are ignoring the fact that their Communist government believes in doing the same thing that the U.S. government does. We are the great capitalist nation and the Chinese are emulating us.

Someone could reasonably say to me that it isn’t really today that we need to be worrying about. It is the future, maybe the intermediate future. I agree. There are certainly significant seeds of terrifying doom planted in today’s economy, i.e., the debt, the made-up money at the Fed, the lack of any savings available for investment, the flood of new regulations, etc. The list is very long. Even worse is the lack of understanding of the true nature of the situation where the decisions are being made or where the decisions are being evaluated, i.e., the press.

Nevertheless, the American economy is not just the government or the Fed. There are millions of other actors who are seeking their best interest and working to achieve their own goals. These people have learned over the last century how to work around and within the government actions to minimize the consequences of those regulations and laws. Their ability to do so is not unlimited. But they have shown amazing creativity and resilience. We aren’t necessarily doomed.

Just as the government and mainstream economists don’t question their premises, those who have cried doom often in the last decades don’t seem to question why that doom hasn’t occurred. At root, they seem to give the government a kind of power in the economy that means that the non-government population is completely helpless and their actions have no consequences. Destruction is inevitable. Consequently, these doomsayers tend to pounce upon any small indication that things are coming apart as proof to the government’s power.

We must keep perspective.

The economy today is wallowing. The people making decisions are idiots. In many respects the average American cannot be relied upon to make good decisions. Even so, there is a lot of good stuff going on in our economy and society (including us). We can make it through with only a little damage. It would help if people listened to us. It would help if the American voters put in a non-Dem house of the legislature. Unfortunately, we can’t count on those events.

So what is the “Outlook”? At best it is very uncertain. Under current conditions and leaders, the best we can look forward to is more of what we have had over the last couple of years: no growth and floundering. With some positive results in November, maybe things will move toward the early part of this decade (not really good but better than now). But the potential is there for disaster. It isn’t unavoidable, just a potential.

What next? Negative Interest?

A couple months ago I saw an analysis that showed the rate of interest targeted by the Fed Open Market Committee had declined over the last twenty years or so. Each cycle showed the targeted interest rate to be lower than the previous cycle. The question posed was, what would happen the next time, and if the economy gets going again, there will be a next time, But the Fed is already at zero. What will they do?


The target interest rate is what we hear called the Federal Funds rate or the Discount Rate. It is the rate the Fed charges banks, members of the Fed, to borrow from the Fed to maintain the minimum level of their deposits (sometimes called reserves) at the Fed. The law that set up the Fed. requires all member banks to maintain deposits (reserves) at the Fed. These funds are not available to the bank to use for any purpose except the Fed’s manipulation. The amount of the deposits that a bank must have with the Fed is a percentage of its demand deposits, called checking accounts by you and me. The Open Market Committee decides what percentage of demand deposits a member bank must have on hand, currently 10%.


If a bank’s deposits falls below 10% at any point, the bank must either deposit funds, borrow from another bank, or borrow from the Fed. And the Fed charges an interest rate, which, as I said, is called the Discount Rate or the Federal Funds rate. This is the interest rate that you hear or read about all the time in the popular press. It is considered a big deal. “Investors” buy or sell on expectations about the rate, banks connect their “Prime Rate” to the Discount Rate, mainstream economists connect their predictions on the economy based upon the Discount Rate, and so on.


The Discount rate is not maintained by decree, actually. It is a market rate, which is why it is called a target. The Fed. maintains the rate by adding or subtracting the amount of money available for bank member borrowing to cover minimum Fed. deposits. Ultimately, this is how the Fed. manipulates the money supply, but adding or subtracting money in the member banks Fed. deposit accounts (see elsewhere in my blog for a detailed explanation).


Therefore, the Fed. lowers the discount rate by adding money to the economy through the banks deposits. Currently, the Fed. Discount Rate is 0.00 to 0.25%, or nothing. The rate has been zero for well over a year. Supposedly, when rates are low, banks will loan more money, and, in current “thinking”, the economy will whiz along. Oh. You noticed no whizzing? What a surprise. Actually, banks have been contracting lending for well over a year, both to businesses and to consumers. Even with a zero percent interest, the Fed. can’t get the economy going. Even with the “stimulus” packages, they can’t get the economy going. What a surprise.


The chart I mentioned at the beginning suggests that future efforts of the Fed. will have a problem. That each successive round of encouragement from the Fed. has required lower interest rates. Well, you can’t get lower than zero. Free money would seem to be the ideal from these people. Hmmmm. The current situation is somewhat confused by the fact that the Fed. is paying interest for the first time ever on the Fed. member bank deposits. Before September, 2008, the way banks made money on expanded Fed. deposits was by taking 90% of the dollars the Fed. had given them in their member deposit account into their bank and loaning those dollars out (theoretically, there was nothing stopping them from just creating new demand deposits in their bank that equaled ten times the new Fed. deposits, but accounting niceties kind of made that difficult). Because the Fed. had created a massive amount of member bank deposits, about $1T vs. the normal $50B, the Fed. wanted to encourage the banks to keep the money at the Fed. so it began paying interest (not much, but more than zero). It turned out that it wasn’t necessary to offer interest, since the banks aren’t lending.


The Fed. keeps talking about the time when the economy begins growing again and it can raise interest rates, absorb all that money it created, and wallow in its self congratulations. But, here we are, a few months from two years of Fed. and BO encouragement, and no recovery. Some slight good news is published and everybody gets excited, and the next week there is new bad news and everyone feels worse. Unemployment figures continue to look bad. Well, I won’t dwell on the sorry picture.


So the chart I mentioned implies that if and when things get going, to the extent they can go at all with the huge burdens the BO has saddled us with, the Fed. is going to have to keep interest rates lower than in the last cycle, which was lower than the cycle before that. Of course, that will mean huge flows of made-up money, both in bank credit expansion and government spending, asset inflation, price inflation (currently 2.4% in the much criticized CPI), and probably very slow, real growth. Then, a couple years down the road the next bust comes (in a shorter cycle, I would think), the Fed. will have nowhere to go. The interest rates for the boom would be very close to zero, say 1-2%, and zero will not do much, probably even less than now. True to his convictions, Bernanke, the Fed. Chairman, will have flooded the country with more made-up money (we need to start calling him “Flood Money” Bernanke), and the next recession will just continue. We can expect more condemnation of capitalism, more destruction of our productive capacity, further crippling regulation of our financial system, a move toward greater violence and despair, and no economic growth or future. At least the cycle of boom and bust might have come to an end.

"Too Big To Fail": Financial Reform

As you would expect, the mainstream “experts” have it all wrong. Their idea of reform of the financial market is to attack the companies. They, the “experts”, decided when the financial crisis hit that some financial companies were “too big to fail”, and that the government must step in and “save” them by pouring mountains of money down drain holes. These companies were insolvent and needed to be liquidated, but the “experts” argued that the government must not let that happen, the consequences, they said, were too dire. But, people in general didn’t really buy off on that. There was enough of a ruckus about the massive amount of money spent in the bailouts that the “experts” then argued that something had to be done to avoid this problem in the future. Now, of course, that “something” did not include any suggestion that bailouts shouldn’t be made, or that the cause of the problem in the first place might be to government policy.



Now the Congress is considering what to do. We are now hearing from those same “experts”. As pointed out elsewhere (e.g., Meltdown by Thomas Woods) these “experts” are the same people who said that the rise of residential real estate prices was not a problem, that the types of mortgages being offered wasn’t a problem, that the increasing foreclosures wasn’t a problem, and that the initial problems with financial institutions wasn’t a problem. Why is anyone listening to these people now? Apparently, no one in the government and the media has the capability to learn from past mistakes. They certainly do not posses the ability to question any belief that they hold, let alone the ideas of the “experts”.


So the Congress is considering the issue of “reforming” the financial industry. The answer is of course, more regulation, which will mean more unproductive cost and layers of government employees with arbitrary power. But there is one proposal to which we should pay particular attention.


The answer to the “too big to fail” problem, it is shouted, is to reduce the size of the American financial companies. This is said, ironically, in the face of the fact that the solution to the potential failure of many financial companies was to push them off on other not-so-bad-off large financial companies, making the resulting companies much bigger. All of those companies that assisted in the “solution” to the last bust are now to be reduced in size.


One of the architects of the original mess, the crisis, the bailouts, and the lack of recovery, the Chairman of the Federal Reserve Board, Ben Bernanke, was recently speaking to a banking conference. He said, “If, in the end, funds must be injected to resolve a systemically critical institution safely, the ultimate cost must not fall on taxpayers or small financial institutions, but on those institutions that are the source of the too-big-to-fail problem,” Bernanke continued in his speech to the Independent Community Bankers of America. “It is unconscionable that the fate of the world economy should be so closely tied to the fortunes of a relatively small number of giant financial firms,” Bernanke said. “If we achieve nothing else in the wake of the crisis, we must ensure that we never again face such a situation.”


Any history of the world financial markets will record that the push to increase the size of the major financial firms came from two sources, one is the market and the second is the actions of governments. The market would make the scope and range of activities in our world market pushing toward the ability of a financial firm to meet the demands of large, international companies, both in the lower costs of scale of a large company and the ability to work in the large size of the transactions required. The governmental actions were, to name a couple examples, the additional costs that regulations impose, which are easier to absorb for larger firms, the fact that the size of the funds is made larger than necessary by the constant inflation that central banks create, and the success of larger firms in receiving government handouts and favors (and giving the support that legislators require; this list of government influences is not meant to be exhaustive).


To the extent that American financial firms are forced to downsize, in contrast to their competitors in other countries, American firms will encounter a competitive disadvantage. The financial center of the world could and most likely will swing away from New York toward the East. We will see a self-imposed degradation of the United States and its ability to maintain a competitive position. American non-financial firms will tend to move toward foreign companies to meet their international financial requirements. American financial firms, being smaller, may be picked off and purchased by the larger Eastern institutions.


It may be the case that the U.S. government “experts” will attempt to encourage their foreign counterparts to follow their lead and downsize foreign financial firms. To the extent that all financial firms are downsized, we will see a curtailment of international activity as financing becomes less available. But, some countries will see the benefit of being financial giants, in a world of pigmies.


We will be seeing another step in the continuing destruction of the United States of America as a economic powerhouse and standard of freedom and individual liberty.

PARALLELS, NASTY ONES

My perspective is economics, not that I am unaware of or concerned about the philosophic, moral, or political issues, but other people are writing about those and doing a fine job. I don’t see a reason for duplication. I don’t see much written about the economic implications and that is more where my experience and education lies, so, with that in mind, let me ask:



Do you notice the parallels between FDR and BO? Both began office after a huge dive in the economy: the stock market dove spectacularly in both cases, unemployment has soared to similar heights, there were financial crisis in both cases, both were preceded by Republicans who are regarded as somehow pro-capitalism but aren’t, both have pushed through public works bills, both pushed for overhauls of major parts of the economy, both are presenting themselves as saviors, and both are more concerned with power than any other issue. I am sure that there are more economic parallels.


Here we are into the second year of BO’s presidency, and, in spite of what the Fed and other government economists say, we are still in the recession. Unemployment is expected to remain high for years to come. Businesses and banks are unsure as to what to do because of the uncertainty as to what BO and his Congress will do to them in the near future. Further, what BO has done recently promises to weigh down the economy with massive expenses, higher federal debt, and tighter restrictions on production.


In other words, we have no good reason to think that our future will be any different now than the people in the 1930’s experienced. (It is true that BO has not started destroying food. Don’t put it past him.) To say this correctly, we are currently headed for continued recession that could last for years. Since BO, Treasury Secretary Geithner, and the Fed’s Bernanke do not know why the economy is not recovering, and would not consider freedom as an acceptable solution to the lack of recovery, we can expect more “solutions” that will sap our savings, and drive us further into recession/depression. Last time the Great Depression lasted 16 years without any questioning of the doctrine that kept us from prosperity. Even after the economy began working again, in 1946, when FDR was dead and Truman had put in his own people, no one questioned how the economy recovered without the government’s input. Today, no one is asking why the “recover” is so slow. Instead, they are doing everything possible to prevent recovery.


Further, after 70 or so years of encroachment by anti-capitalist measures, our economy has less vitality and room to maneuver than it did in the 30’s and 40’s. The government has more tools to manipulate and degrade economic performance today than it did before.


On the other hand, in some ways current businesses are more flexible and know more about their businesses than business managers in the 1930’s. Further, American businessmen have nearly a century of experience of how to work around government regulations and manipulation. That is not to say that they can bring our economy out of the recession, but they may be able to maintain their own and be modestly profitable. The large number of businesses dependent on government handouts will be a drag, as they continue to absorb savings and made-up money. It might sound as though this paragraph contradicts the previous one, but I am looking at the problem from first the restriction side and then the victim side. I don’t know which one will dominate, but both trends exist.


Frankly, what we have is uncertainty all around. But, keep in mind that uncertainty, in this circumstance, is a better condition than outright deterioration or a further dive.


In terms of your own situation, the best advice is to keep flexible. That doesn’t mean to stay in cash, including foreign cash, because cash is a guaranteed loss in a time period longer than a year. That doesn’t mean all gold, because the gold price, as we have seen over the last year, is bounced by many factors besides being a store of value. It doesn’t mean all foreign investments, because foreign economies are being buffeted by the same factors as the U.S. economy, including their own governments and central bankers. Foreign economies are also very dependent upon the U.S., so if we are failing, the likelihood of their flourishing is low.


What I think your best position includes is diversity, more so than ever, including foreign and domestic stocks, cash, foreign cash, and etf gold (least expensive way to hold it). No bonds of any kind. You do not want to be a lender in these circumstances.


Residential real estate is risky. If the situation is that your job could be in jeopardy, trying to hold on to the house could be a major problem. Buying today, even at low rates and lower prices is no guarantee that the purchase will work out for you in the next five years. If you have owned the house for some time and have equity in it, and the payments are relatively low, and you have some reserves, you are in a decent position. The biggest problem in these times is that the mortgage payment will tie you down, reduce your flexibility, and tend to present an inducement to remain in a perilous circumstance.


More than ever, you need knowledge. You need to know how these markets work. You need to know how the dollar relates to other currencies and foreign assets. You need to know how to watch your countries inflation monitors. You need to know what sources you can trust.


How long will this uncertain-stage last? It has lasted for several months so far, since the rush to dump employees slowed. We are waiting to see what effect BO’s massive new debt will have, we are waiting to see what the Fed does with all the money it created, we are waiting to see what consequences the new wave of regulations on all parts of the economy will have, we are waiting to see if BO can carry forward his massive expansion of government, and we are waiting to see if people are actually beginning to resist BO and the Dems. Combined, all of these issues are bad for even maintaining the current lull.


Prosperity is very unlikely if even a few of these economically stressful government activities come to fruition. I do not expect prosperity without at least some movement away from the future the present government and Congress have planned. Let’s say the Republicans win significantly in November. Will that mean that they will back us off of what BO will have instituted in his two years? It is unlikely. They may just decide that it is an opportunity for their brand of fascist state.


We could also see the economy begin a slow dive, not a panic, but just a decline as businesses find that they are not able to pay their debts or payrolls. This decline will not be signaled by any specific event. It could even be hid by the government’s statistical procedures. Just keep an eye out for a lack of growth, lack of non-government hiring, government talk of some segment or other of the economy failing to do their part, and the housing sector seeing more foreclosures and lower sales.


We may end up wishing we had a John Galt to unplug the minds keeping this thing alive.


Now, my focus is our economy. But as I said at the beginning of this post, I know that there is connection between the moral, political, and the economic, i.e., without freedom we cannot have a productive, prosperous economy. Without the morality of reason, of self-interest, we cannot have freedom. I am an advocate of individual rights and lazi-faire capitalism, of the virtue of selfishness.


I am talking to those whose fight is to achieve freedom. I merely want you to protect as much of your personal wealth and wiggle room as possible.

"Eliminating Reserve Requirements"

There is one thing that is wondering around various commentators that I hope that you do not get caught up in. Ben Bernanke, Chairman of the Federal Reserve, is quoted, correctly it seems, in saying that he would like to see the eliminating of the reserve requirement.



Every commentator that I have seen so far is screaming and carrying on about how horrible this is that the Fed wants to eliminate bank reserves. They are a little confused. They apparently do not realize how banks function, especially within the United States and within the Fed.


Each bank in fact has two reserves. The bank keeps on hand possibly five layers of reserves. There is the cash on hand to meet the daily cash requirements of its customers. There is the digital balance it keeps on hand to meet the demand for check transfers and transactions. They also have reserves to cover loans that go bad, so that they can replace the demand deposit (checking account) balances. There is also part of their loan portfolio that consists of government bonds and other assets that may be turned into “cash” quickly. Finally, there is the capital account, made of the equity that was invested by the shareholders. (Note that the loan-loss account and the capital account may be kept in government bonds or other liquid assets.) Bernanke’s proposal has nothing to do with these account and reserves. He is not suggesting anything to do with a bank’s operating methods or what passes for safety in today’s banking environment.


The bank has one other “reserve”. It is the percentage of its demand deposits that it has to have deposited with the Fed. This deposit, called a reserve by the original legislation that set up the Fed, is not a reserve in any rational sense. The bank has to have these funds on deposit with the Fed by law and if by chance the percentage of the deposit vs. the amount of its demand deposits in the bank falls below the current requirement (today it is 10%, including cash in the bank’s vault, which is as low as I know of in the history of the Fed), then the bank must either move money immediately or borrow it from another bank (the inter-bank rate) or the Fed (the discount rate or Federal Funds rate).


It is this totally useless Fed deposit that Bernanke is suggesting be done away with. Which, on the face of it, doesn’t seem like a bad idea. I am interested in how Bernanke is going to carry forward the purpose of the Fed, which is to manipulate the money supply, expand bank lending, and make inflation a constant in our lives. It will be interesting to find out.


Actually, this isn’t anything worth paying much attention to, since it will not affect much that will make a difference. We will still have the Fed destroying our assets and ignoring that they are doing so.

Bernanke's Confirmation: No! Err... Well....Okay

Ben S. Bernanke, the Chairman of the Federal Reserve Board, is facing some opposition in winning a confirmation for his second term as Chair. As a man who is nearly universally proclaimed as the savior of the American economy from a deep depression, it seems amazing. The mainstream press has been a cheerleader and books have been written extolling his heroics. What is happening?



My own view of the man is spread throughout this blog, especially in my comments on his speech on January 2nd. He practices a science that is tailor made to not learn of causal relationships. He gives the impression of being non-political. He appears to be the ultimate academic bureaucrat.


Bernanke always appears poised and rock solid in his pronouncements and prognostications. This is his view of how a Fed Chair should be. Unfortunately, he appears rock solid regardless of the veracity or wisdom of his statements. Here are some examples: He appeared poised and rock solid when he said that there was no problem with the rise in housing prices a couple years ago. He appeared the same when he said that the problems with foreclosures would have no impact on the economy. He appeared the same when he said that Fannie Mae and Freddy Mac were in excellent financial health. He appeared the same when he and the Treasury nationalized the failing Fannie Mae and Freddy Mac a few days later. He appeared the same when he began nationalizing banks and put a couple trillion dollars into the economy. He appeared the same when he said that events that coincided with injections of money were coincidences. He appeared the same when he said that the probable cause of the foreclosure problem was the use of risky mortgages offered to substandard credit borrowers, even though he knew that the Fed had pushed with the rest of the Federal government for lowering credit standards for mortgages for years. The guy has an appearance that does not connect to the real world.


I also think that any man who accepts the chair of the Fed has to be regarded as having a questionable psychology. This is one of the most powerful, political positions in the world. Anyone willing to accept that much power over his fellow man has problems.


At this point, there is very little suggestion in the mainstream press that the Fed is responsible for the house price bubble. As I mentioned, there is nearly universal acclaim for his leadership in keeping the U.S. economy from depression. Why then is his confirmation being opposed by several Democrats?


The good news is that several democrats are criticizing Bernanke for the bailouts. The bad news is that they are criticizing the bailouts primarily because these politicians think the companies bailed out are unpopular. It is a play of the class warfare card.


It is okay, they think for the Fed to have pumped a trillion or two into the economy. It is okay for him to have wielded the power he has, along with the Treasury.


One set of criticisms of Bernanke is that he gave too much money to AIG and did not add conditions. These criticisms aren’t that Bernanke bailed out AIG, but that he didn’t do it in a certain fashion. Somehow, in his headlong dash to dole out all the money he could create, Bernanke was suppose to make sure that the money wasn’t suppose to be used for AIG’s actual business, which, in this case, was to insure certain investments tied to mortgage backed securities. If AIG failed to meet its contractual obligations, those companies would suffer sever difficulties and many would fail. What was AIG suppose to do with the money? These congressional critics are all for the use of government money as a means of manipulating the economy, confiscate assets, and generally extend the government’s reach, but they are outraged that the money was used for contracted, normal business activities. It is just another example of the attitude of the political climate that the importance of contract is ignored and denied. The worthiness of attacking a person because their actions inadvertently helped a company that can be attacked for political gain.


One criticism that I have heard only a little is that he has lied at several stages of the bail-out. He lied to BoA on the financial health of Merrill Lynch, and then when they found out the depth of the problem he threatened the Bank’s leadership and implied that he would put someone in their place who would do what he, Bernanke, wanted. The man feels as though he may do as he pleases with his power. He lied about the AIG deal and his representatives at the New York Fed told AIG to keep quite (for which the AIG officials are blamed with the suggestion that AIG instigated the deceit, when it was obviously the Fed). He has lied about the role of the Fed in the lowering of credit standards for sub-prime mortgages, implying that it was the nefarious and evil mortgage brokers, who had only their jobs and businesses to loose. The man apparently feels that any statement he makes is acceptable because he is “saving” the country from depression. He must “do all it takes”, which means forcing people to do what is not in their best interest. At best, Bernanke believes in sacrificing others for the sake of “the greater good”. Not to psychologize, but it is just as possible that he just likes the power.


I have seen that many people are happy that Bernanke may be rejected. They are joining the chorus, albeit a small one at the moment, in calling for his confirmation to fail. Bernanke should be fired, at the very least. He should not continue in a post that he doesn’t understand and mishandled so badly. I cannot deny that I too would feel good about the Senate sending him home. But. But! BUT! There is a small, okay, a big problem.


If Bernanke, the lying, self-deluded, power craving, freedom destroying, bureaucrat loses his job on Sunday. What happens? Obama gets to appoint a new Fed Chairman. Obama. Obama gets to appoint the person who is quite possibly the most powerful person in the world economy. Obama.


I am afraid. The prospect of Obama placing a person in the Fed Chair frightens me more than Bernanke does.


I have not kept track of Obama’s appointments. But from what I can tell, his people are radical, anti-freedom socialists and fascists. I am not aware of a single competent person. The guy at the Treasury is the one who forced through much of the current economic plan as head of the New York Fed. He came to the government from Goldman Sacks, and he turns out to be a pragmatist of the first order, willing to use government power to control and manipulate. He is not a capitalist. If there are people in Obama’s administration who do not want to actively expand government power, they haven’t made an impact.


So, what can we expect from an Obama appointment that could get through the Senate confirmation process? Anyone who has paid their taxes, including their nannies taxes, who will use the Fed as the means to further corrupt, undermine, and destroy what little remains of our freedom and capitalistic system. Is that better than Bernanke? Bernanke’s one little bitty redeeming piece of character is that he is an academic, as corrupt and pragmatic as that is. He is not overtly political. He is certainly not a supporter of capitalism, and he has shown no willingness to oppose any of Obama’s drive to fascism. Nor will his policies help stabilize and strengthen the economy. But, he is not going to act as Obama’s pawn or tool in the manner that Obama’s own selection would. It is a small difference, but sufficient that I am willing to argue for Bernanke’s return for another term.


If you want to argue that putting Obama’s person into the Fed will make our current situation much worse and that people will rebel against Obama and the destruction of our freedom I am willing to listen. But, I think that it is too early for us to do that. People don’t know any more about freedom and capitalism than they did three years ago. It is still too soon. I think that we can use more time in a slowly deteriorating situation to further our efforts to save our freedom and the United States of America. I want more time.

Speech by Ben S. Bernanke, Commentary

Monetary Policy and the Housing Bubble
At the Annual Meeting of the American Economic Association

January 2, 2010

This is a speech in front of an association of economists, and, consequently, Bernanke can talk freely in his “native language”. He can use the reasoning and terms with which he is most comfortable, keeping in mind that it is in public and the speech will be reported. This speech is his personal, professional statement of what he considers to be the consequences of his actions as a government official.

First, Bernanke’s comments make clear that in his opinion, the range of options that he faced or would not consider appropriate do not extend to letting interest rates rise to the market level. Those who argue the rates were too low, he says, meant that he should have done something different, not leave his hands off. As he was reported to have said in the book In Fed We Trust (p. 21), he was unpersuaded by arguments that the market can be effective by itself. In addition, he says that he was afraid of an unwelcomed decline in inflation. He was afraid of deflation, referring to Japan as an example of what can happen if prices fall.

“…the FOMC’s policy response also reflected concerns about a possible unwelcome decline in inflation. Taking note of the painful experience of Japan, policymakers worried that the United States might sink into deflation and that, as one consequence, the FOMC’s target interest rate might hit its zero lower bound, limiting the scope for further monetary accommodation.”

That he has no evidence that deflation in the U.S. was happening, or that it would have been bad is not considered. What he is actually saying is that falling prices is a bad thing for any economy. Falling prices are to be avoided at all costs. Falling prices, plus the potential for large scale problems in the financial sector world wide meant probable depression.

Bernanke has established himself as an expert on the Great Depression. His take on the depression is that it could have been avoided if the Fed had flooded the market with money in 1931 and 1932. This is his perspective. If something goes wrong in the economy, lower the interest rates.

Bernanke’s speech begins with discussion of the level of the overnight federal funds interest rate between 2002 and 2006. The question is whether it was appropriate in the face of the critics. He thus says that he will begin with a discussion of “simple rules” that have been offered to determine the proper rate, and talks about one, only one. And with the conclusion of this discussion, he simply dismisses the issue of the interest rate levels by saying that it appears that the Fed followed the correct policy.

The “simple rule” is a formula suggested by an academic that includes the actual rate of inflation, the desired rate of inflation, and the deviation from the optimum level of production. Bernanke quibbles about some of these terms, and ends by declaring that, even if the final result, after he has tinkered with the terms, is close to what the short-term interest rate goals that the Fed actually achieved, it is still too restrictive to be used. Sound strange? It is. I don’t recommend reading that section (or any of them, really; what’s that fun saying that some media types are using, “I read it so that you don’t have to”). (I am sorry. This section of the speech, about 25% of the text, is just not easily translated.)

He also uses only the level of prices, consumer prices as the subject matter of inflation. If prices rise there is inflation. If prices fall there is deflation. He is not willing to suggest that there is any other set of issues. Money supply is not an issue. It is not mentioned during the speech. Other causes for price rises, such as restrictions on oil production and thus higher oil prices, which tend to make other prices are not considered, at least in this speech. (He would probably like this suggestion, since it would be yet another explanation of “inflation” in which the central bank played no part.)

As you would expect, the concrete-bound detail and triviality of his remarks make this extremely tedious to read, as, I am sure, to hear by his listeners. Of course, they were mostly mainstream economists and government people and are used to hearing this kind of speech.

He then asks “can monetary policy have made an impact on housing prices?”

“With respect to the magnitude of house-price increases: Economists who have investigated the issue have generally found that, based on historical relationships, only a small portion of the increase in house prices earlier this decade can be attributed to the stance of U.S. monetary policy. This conclusion has been reached using both econometric models and purely statistical analyses that make no use of economic theory.”

Bernanke’s answer is founded in statistical analysis. He doesn’t use cause and effect, but looks for correlations. These techniques also depends upon focusing on the interest rate at the time and price inflation. What they ignore entirely is how low interest rates are achieved. He pretends that the fed declares low interest rates and they come about. But what happens is that to keep interest rates low, even the short-term rates, the Fed must supply funds. It must make up money. It must keep making money (this is electronic money) as long as it wants to keep the interest rates below what the market would set. Every time there is a move upward, the Fed makes up more money. Where does this money go? In the period in question, much of it went into mortgages. But Bernanke does not think that looking at this money makes any sense. He ignores it as if it doesn’t exist. But it does, or did until the liquidation of mortgage-backed securities became necessary because of so many defaults, which was the liquidation of the mortgages.

His entire speech demonstrates that the epistemological methods used in today’s mainstream economics is designed to avoid looking at reality and to obfuscate cause and effect.

He slips in the suggestion that the availability of ARMs and other special mortgage types is a “key” explanation of the rise in house prices.

“Clearly, for lenders and borrowers focused on minimizing the initial payment, the choice of mortgage type was far more important than the level of short- term interest rates. The availability of these alternative mortgage products proved to be quite important and, as many have recognized, is likely a key explanation of the housing bubble.”

At this point the level of evasion of responsibility becomes obvious, since the Fed, as well as every other imaginable government agency had pushed home ownership and the lowering of credit standards for years. (see Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse by Thomas Woods, p. 15ff)

“As you can see, the use of these nonstandard features increased rapidly from early in the decade through 2005 or 2006. Because such features are presumably not appropriate for many borrowers, Slide 8 is evidence of a protracted deterioration in mortgage underwriting standards, which was further exacerbated by practices such as the use of no-documentation loans. The picture that emerges is consistent with many accounts of the period: At some point, both lenders and borrowers became convinced that house prices would only go up. Borrowers chose, and were extended, mortgages that they could not be expected to service in the longer term. They were provided these loans on the expectation that accumulating home equity would soon allow refinancing into more sustainable mortgages. For a time, rising house prices became a self-fulfilling prophecy, but ultimately, further appreciation could not be sustained and house prices collapsed.”

To further support his position that the Fed is blameless, he considers the rise of house prices internationally. Bernanke uses the same statistical method of comparing monetary policy, as represented by a statistical analysis of the central bank short-term rates compared to the rise of house prices in separate countries. He finds no correlation. So the central bank of the U.S., the Fed, did not cause the rise in house prices. QED! The guy is a wizard! And, it is entirely nonsense. He has no concept of the role of cause and effect in economics. That is where we are, and why he and his brothers are completely mystified as to why people want to shut them down.

So what explains it, in Bernanke’s opinion: savings glut, especially in developing countries. It seems that the people who feed off of money loaned or “invested” in developing countries turn around and put the money in the U.S. Since this money is usually dollars and it isn’t actually U.S. savings, but made-up money, it is U.S. inflation anyway. But that is far too long of a chain for Bernanke to accept or even consider. Yet, here we are, foreign savings sent to the U.S. has driven up American house prices.

Step back and consider our house prices dependency on foreign money for a second. With Bernanke is keeping American interest rates low, why would anyone send us money. Well maybe, if your own country’s currency is even less stable, the U.S. is a fine place to put your money, or maybe you have so many dollars you need someplace to put them.

Somehow Bernanke can keep track of the money coming into the U.S., he says (actually, he is suggesting it, cause and effect is something that he is avoiding), but he can’t or won’t consider what is being done with the money the Fed is creating to keep the interest rates low in the first place. There is a parallel, Bernanke admitted in front of Congress that he doesn’t know what happened to the money that he loaned/gave to foreign central banks as part of the stabilization after September, 2008. He doesn’t watch it, except for that money that came from developing countries that drove up house prices in the U.S.

“In previous remarks I have pointed out that capital inflows from emerging markets to industrial countries can help to explain asset price appreciation and low long-term real interest rates in the countries receiving the funds -- the so-called global savings glut hypothesis (Bernanke, 2005, 2007).”

In his argument that central bank short-term interest rate policies are not responsible for the increase in house prices, Bernanke’s approach shows that there is a very significant methodological issue here. Bernanke felt that all he needed to do was create charts comparing the central bank interest rates with the house prices. He didn’t feel it was important to consider the actual money market in each country, or credit standards, if credit is used, type of mortgages, income levels of house purchasers, laws, or any feature that might or might not make each county a relevant candidate for comparison with the U.S. situation. No, all that is needed in Bernanke’s world is a look for the correlation. I have watched reactions to Bernanke’s speech and I have seen no reaction at all to his analytical methods. I suspect that the standard journalist is intimidated by what passes as Bernanke’s science. I saw one comment on a critic’s article saying that he thought Bernanke was smarter than the author of the article and so would continue to believe Bernanke. That is part of the problem, a lack of understanding of simple methodology.

And, therefore, after his analysis of the appropriateness of his low short-term interest rate policy and the possibility of Fed responsibility for the rise in house prices, both of which Bernanke resolved in his own favor, the cash payout, the conclusion, the recommendation is, wait for it, what do you think, you get three answers and the first two don’t count, what do you think it could be….(consider this all said in a high voice with a drum roll)…… it is, to da, MORE REGULATON!!!! SURPRISE!!!

Sorry, I couldn’t resist.

“What policy implications should we draw? I noted earlier that the most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards. That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary. Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates. Moreover, regulators, supervisors, and the private sector could have more effectively addressed building risk concentrations and inadequate risk- management practices without necessarily having had to make a judgment about the sustainability of house price increases.

“The Federal Reserve and other agencies did make efforts to address poor mortgage underwriting practices. In 2005, we worked with other banking regulators to develop guidance for banks on nontraditional mortgages, notably interest-only and option-ARM products. In March 2007, we issued interagency guidance on subprime lending, which was finalized in June. After a series of hearings that began in June 2006, we used authority granted us under the Truth in Lending Act to issue rules that apply to all high-cost mortgage lenders, not just banks. However, these efforts came too late or were insufficient to stop the decline in underwriting standards and effectively constrain the housing bubble.

“The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter. The Federal Reserve is working not only to improve our ability to identify and correct problems in financial institutions, but also to move from an institution-by- institution supervisory approach to one that is attentive to the stability of the financial system as a whole. Toward that end, we are supplementing reviews of individual firms with comparative evaluations across firms and with analyses of the interactions among firms and markets. We have further strengthened our commitment to consumer protection. And we have strongly advocated financial regulatory reforms, such as the creation of a systemic risk council, that will reorient the country’s overall regulatory structure toward a more systemic approach. The crisis has shown us that indicators such as leverage and liquidity must be evaluated from a systemwide perspective as well as at the level of individual firms.”

The nicest thing that can be said is the he must be well insulated. The push to expand home ownership and lower credit standards by the government was a very big effort. To ignore that takes a heap of mental effort. The other problems I have touched upon.

But, the basic modus operandi of a government regulator is well established by excellent writers, Ayn Rand, Ludwig von Mises, and many more. When something goes wrong in the economy you are regulating always blame it on free enterprise and never yourself. And demand, loudly and often, more controls and power and less freedom.

(Bernanke's speech    http://www.federalreserve.gov/newsevents/speech/bernanke20100103a.htm)